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Public Pension Reform: Will Reforms Abroad Work in the U.S.?

December 04, 2003//11:00pm

On December 5, 2003, the Woodrow Wilson Center's Project on America and the Global Economy and AARP's Global Aging Program focused on public pensions in the third meeting of their joint series exploring the opportunities and challenges posed by aging in the industrial democracies. In particular, the session asked if public pension reforms abroad held lessons that might be applied in the United States. A packed audience in AARP's Brickfield Center was joined by AARP affiliates in New Hampshire and Texas via video link and by the Colorado affiliate via radio.

In a substance rich hour and a half, a distinguished panel spelled out several key lessons. First, reform is possible. Despite headlines focused on strikes, strident parliamentary debates, and even falling governments, European countries have been adapting to shifting demographics by making a series of modifications to their pension systems. Second, just as the United States has often looked to its own states as 'laboratories of democracy', the differing pension reforms adopted by the industrial democracies offers the United States a rich menu of possibilities. Third, the other industrial democracies are adopting or moving toward tiered systems in which public pensions are complemented by private pensions and, individual savings. Fourth, a large percentage of the baby boom generation indicates a desire to continue working at least part time after normal retirement age. As yet, however, neither the retirement system nor private employers have adapted to a world of part-time retirement.

John Rother, AARP's Director of Policy and Strategy opened the sessions by identifying AARP's four pillars of retirement security – Social Security, private pensions and personal savings, income from continued employment, and health insurance. Not surprisingly, the AARP membership focuses on Social Security and Medicare. Polling results show that AARP members view as very important the defined benefit nature of social security and the automatic cost of living adjustment (or COLA). The members also endorsed the progressive nature of the system and the link between contributions to the system and received benefits.

Rother also stressed the somewhat disjointed nature of the American retirement system. Under some government and private plans, workers can retire at age fifty-five. Penalty free withdrawals from Individual Retirement Accounts (IRAs), however, start at age 59 and a half. Reduced Social Security Benefits start at age 62 but, depending on an individual's age, full benefits may not start until an individual reaches 67. To access Medicare, the important health pillar of the system, an individual must generally reach 65.

Dalmer Hoskins, Secretary General of the Geneva, Switzerland based International Social Security System added a broad, international perspective. In seeking lessons for the United States, Hoskins looked at the countries belonging to the Organization for Economic Cooperation and Development (OECD), an organization that includes virtually all the industrial democracies.

After reviewing OECD policies, Hoskins reached several conclusions. Reform was possible. Press coverage of political opposition to pension reform in Europe often obscured the fact that considerable reforms had already taken place. He cited a number of European examples where there had been almost yearly changes in pension systems to adapt to aging societies.

In making reforms, OECD countries adhered to the same basic structure. Publicly supported pensions were viewed as insurance, not as delayed compensation. They all involved shifting income among generations (with working adults supporting older retirees) and all involved a degree of income redistribution to compensate for the vagaries of talent and luck.

Most OECD countries made reforms with an eye to the adequacy of overall retirement income and with an awareness of how the different pillars of their respective systems fit together.

Many of the European countries were taking steps to create a second tier of retirement income to supplement publicly provided pensions. France, Italy and Belgium were turning to tax incentives to encourage private insurers to manage an added tier of retirement. Germany and Sweden were offering incentives to encourage private savings for retirement while Denmark and Finland had made additional savings mandatory. The incentive based approach in Germany had met with a limited response, in part, Hoskins believed, because public information about the option was so inadequate.

Several OECD countries provide for early retirement, with few working beyond age 60. In part, the pattern of early retirement may reflect the lack of age discrimination laws in other countries. But, with unemployment in many European countries reaching double-digit figures, earlier retirement is seen as opening up opportunities for younger workers. Many observers link the high rates of unemployment to the less flexible, European labor market that protects jobs and offers ample benefits. In response, employers are turning to a growing number of contract workers who, while paying the basic taxes, often make no contributions to the second or third pillars in an overall retirement system. Some Europeans are also concerned that the mix of regular and contract workers will gradually lead to a two-tier society.

In the United States, there has been no major reform since 1983, when Congress adopted some of the recommendations of the 1983 Social Security Commission. The Commission, chaired by current Federal Reserve Board Chairman, Alan Greenspan, suggested raising payroll taxes and lengthening the retirement age; the Congress adopted both recommendations.

Hoskins urged the United States to focus on the adequacy of its system. Toward the end of the 1990s, there was considerable discussion about using tax incentives or federal matching funds to encourage savings that would supplement Social Security support. He wondered what had happened to that discussion. He also noted the role that can be played by stakeholders in pressing for pension reform.

Christian Weller, Senior Economist, Center for American Progress, put the discussion of pensions in the context of national income and the health of the overall economy. Weller stressed that funding adequate retirement was a question of the country's willingness to pay; it was a question of what to give up and not an issue of the availability of national resources.

In Japan, a decade of slow growth and intermittent recessions had led to actual deflation (or a falling price level) and rising unemployment. In the eurozone (encompassing twelve of the fifteen members of the European Union), high unemployment and slow growth had combined to create a risk of deflation. He also identified a pattern in which wage growth often lagged behind productivity growth – increasing the share of income going to capital and profits.

In the United States, earnings beyond $87,000 (a figure indexed or adjusted upward with inflation) are not subject to the Social Security tax (or FICA). With growing wage inequality, a growing percentage of national income is not subject to the tax while lower incomes generally mean lower tax contributions.

Weller had a number of proposals for change. He emphasized the importance of having realistic assumptions about the future. For example, the OECD assumes future long-term growth of 1.4 percent while Weller contended that 2 or 2 plus percent was more realistic. At the higher figure, the fiscal position of public pensions is considerably improved. In the case of the United States, which makes seventy-year projections, he noted that the Social Security Administration bases its estimates on the experience of the last twenty rather than the last seventy-five years. Weller was also concerned that politicians were focusing on pre-funding national retirement systems rather than concentrating on the long-run economic variables.

In terms of broader goals, Weller urged policies that reduce earnings inequality and help wages keep pace with productivity growth. He warned against the risk involved in shifting public pensions to individual control.

Robert Pozen, Secretary, Economic Affairs, Commonwealth of Massachusetts, drew on his service as a member on the President George W. Bush's Commission to Strengthen Social Security. He cited a number of possible reforms considered by the Commission that would have a significant impact on the fiscal solvency of the Social Security system.

In his presentation, Christian Weller had raised the possibility of applying the Social Security tax to incomes in excess of $87,000. The 2.9 percent Medicare tax already applied to all income not just that which fell below $87,000. Pozen reported that the Commission did look at the possibility of taxing all income. Current Social Security taxes, however, are in excess of 12 percent. Rather than applying the total Social Security tax to all income, some tax increase advocates proposed applying a 2.9 percent (identical to Medicare) rate to income beyond the current $87,000 ceiling.

The Commission had also considered the President's idea of allowing individuals to invest a portion of their social security taxes in the stock market. Pozen agreed that the bursting of the financial bubble had made the stock market option less attractive.

Pozen also discussed an alternative to the current approach of adjusting initial Social Security benefits to reflect wage growth over a worker's career, rather than rise in prices as we do for post-retirement adjustments to the cost of living. However, a shift from wage to price indexing would reduce the replacement ratio and thereby hurt lower wage workers, who are less likely to participate in other types of retirement schemes or have substantial personal savings. To protect low-wage workers, Pozen proposed a mixed system with initial Social Security benefits indexed to wages for workers below $25,000 per year in average career earnings, and then phasing in price indexing above that amount reaching full price indexing for workers with over $100,000 per year in average career earnings. Pozen reported that such a mixed system would have a hugely positive impact on the solvency of Social Security, reducing its long-term deficit by over 60%.

Pozen further urged reformers to think in more systemic terms. Most importantly, reforms of private retirement plans like IRAs should be linked to reforms of Social Security like the mixed system discussed above, so that increases in payouts from private retirement plans would make up the slower growth in Social Security benefits for higher income workers. In addition, Pozen outlined ways to encourage more contributions to private retirement plans including a universal check off procedure and federally financed matching funds.

Leon Potgieter, Managing Principal, Global Consulting Group, Towers Perrin, summarized a recent Towers Perrin survey on attitudes of employees and employers in the United States toward retirement. Both employers and employees saw the current system as in transition to one that demanded much more self-reliance.

Potgieter noted that the current high rate of early retirement is an historical anomaly. According to the Towers Perrin poll, eighty percent of employees plan to keep working past traditional retirement age. Yet, employees did not see many opportunities for partial employment with their current employers. They generally expressed concern about funding for health care and expected to have a retirement income equal to about 62 percent of pre-retirement income. Respondents were generally overconfident on the adequacy of their retirement savings arrangements.

In terms of policy alternatives, Potgieter pointed to the Australian system, which required a mandatory contribution from the employer to a defined benefit plan. He felt that in most successful models there was a level of compulsion for individuals or companies to provide for retirement. Chile also mandated a certain level of contribution to future retirement but in this case from the individual. Other countries such as Sweden have interesting models where employers provide a share of retirement benefits but this is organized on a national scale. Sweden has started down the road of self managed retirement plans by converting a portion of their social security benefit into a defined contribution account, but do not require added savings.

Amy Borrus, Washington Correspondent of Business Week, acted as a moderator and directed the Question and Answer session. In some cases, a single panel member responded while in others the entire panel may have responded. In summarizing a question and answer, the panel member is usually not identified.

Question and Answer

Borrus posed the first question to the panel: Why had employers not given more consideration to phased retirement?

A: The panel pointed to several possibilities. Because it was difficult to collect a pension and still work, employees themselves may not have pressed for change. Many employers have been adjusting to the need for fewer workers either because of outsourcing or technological change. The prospects for phased retirement or part time employment may rise as the overall workforce shrinks and work shifts from heavy, manual labor and becomes more intellectual in nature.

Q: Would added immigration assure solvency for the social safety net?

A: The panel did not see immigration as promising financial salvation for Social Security. In the panel's view, it would take a 500 to 600 percent increase in immigration to approach balance. If anything, immigration is likely to actually decrease in the post-9/11 world.

In addition, most of today's immigrants work in low-wage occupations. As result, they would generally take more from the Social Security system than they pay in. There could be schemes where a guest worker system could contribute to the social safety net. If granted, for instance, a limited duration work permit with the understanding that at the end of (for example) five years, the worker would receive back half of his or her social security payments with the other half being contributed to the social security system.

Q: Do some countries give retirement credit for care giving? Would such a credit improve the retirement of American women?

A: European countries do provide pension credits for care giving for either children or older parents. The key to improved retirement for women, however, lies more in a decent minimum benefit rather than earning credits for care giving.

Q: Would investing in hedge funds help increase the returns to individual retirement accounts?

A: Hedge funds bring higher returns but higher risks as well. The Panel generally did not suggest hedge funds for the average retiree. In terms of large, state pension funds, however, hedge funds can be an effective way of increasing returns of the total portfolio. Federal rules already allow a small portion of regulated pensions to be invested in venture capital funds.

Q: With people living longer, should we raise the retirement age?

A: The panel noted that although people were, on average, living longer they may not all be much healthier as they near the current retirement age. For individuals who have been in particularly onerous jobs – coal mining, iron working or other kinds of physical labor –postponing retirement could be a serious hardship. Instead of adopting strict longevity indexing, the panel suggested simply adjusting the benefit in line with an actuarial table – giving the people the choice of retiring on the current timetable or continuing to work with the reward of a higher retirement.

The panel noted that different countries had approached the question differently. Sweden did adjust retirement to reflect changes in longevity. France set a retirement age of sixty but then required forty-five years of contributions to receive a benefit.

Q: Can the United States make incremental changes or must the country pursue 'big idea' systemic change?

A: The panel had different views on the question. One panelist saw the United States moving toward comprehensive reforms. Another thought the country was a prisoner of the requirement to have seventy-five year projections. Unless a program solved the full, currently defined seventy-five year funding gap, it ran the risk of being dismissed as being ineffectual. One panelist feared that the perfect solution (solve everything in one step) had become the enemy of the public good. Reducing the project-funding gap by 50 percent would be a major step.

The panel noted that the discussion had focused almost entirely on retirement and not on disability payments. One panelist had detected some growing concern over disability payments and active resentment at the eligibility of immigrants.

Q: Had Social Security caused the very dilemma it now faces? By making retirement more secure, has social security reduced the need for children?

A: The panel noted that the decline in OECD fertility rates preceded the social security system. The decline in fertility rates is more linked to increased education and grater independence for women. The panel added that, at least in Europe, pro-natalist policies have had no effect in raising the fertility rate.

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